Liability-driven investments (LDI) remain “fit for purpose”, although changes in standard market practice in the operation of LDI arrangements will be needed following recent experiences, the Association of Consulting Actuaries (ACA) has stated.

In response to the Work and Pensions Committee's inquiry into defined benefit (DB) pensions with LDI, the ACA stated that LDI remains fit for purpose as a strategic risk management tool.

It also argued that LDI had, overall, “significantly benefitted defined benefit pension schemes”, including during the long period of falling yields driven by quantitative easing and during the pandemic.

However, it acknowledged that some changes may be needed in light of the recent market turbulence, such as LDI arrangements holding collateral to support at least 300 bps or more of yield rises, highlighting evidence that some schemes have already done this.

In addition to this, the ACA argued that the provision of information from LDI asset managers will need to improve in terms of the content and the speed of providing the data.

The ACA also warned that proposed legislative changes for DB schemes currently in the pipeline could risk exacerbating some of the changes.

The association explained that the DB draft regulations would require schemes to aim for a tightly prescribed low dependency investment allocation as they become more mature, and to have a low dependency on the employer once they reach “significant maturity”.

A typical way for schemes to achieve this would be greater use of LDI approaches which, therefore, has potential unintended consequences, such as increasing systemic risks in future by encouraging all DB schemes to invest in very similar ways, the ACA warned.

ACA chair, Stephen Taylor, commented: “In our view, LDI has overall significantly benefited defined benefit pension schemes, in particular during the long period of falling yields in part driven by quantitative easing and during the pandemic.

“However, given recent market challenges, we believe there will now need to be changes in standard market practice in how LDI arrangements operate, such as minimum levels of collateral”.

ACA investment committee chair, Vanessa Hodge, added: “Most DB trustees have well established, formal plans to source additional collateral when needed to help support their hedging arrangements.

“Given the unprecedented speed with which gilt yields rose between late September and mid-October, the pace with which assets could be disinvested and transferred will have caused challenges for some pension schemes despite overall funding levels having improved in many cases.”

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